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CORPORATIONS CONDENSED OUTLINE Characteristics of a Corporation 1. Formal creation: articles of incorporation, bylaws (easily amendable) a.

shall engage in any lawful business b. Charity lots of discretion 2. Shareholders a. Duty of care b. Duty of loyalty 3. Separation of ownership and control a. If ownership is not separated co-mingling of assets, etc, then the corporate veil can be pierced 4. Complete, unfettered transfer of ownership a. Except in closed corporations: transfer agreements, voting pools, etc. b. In closed corps, there is greater unity of shareholders and management 5. Indefinite duration: lasts even when directors, shareholders die 6. Limited liability: shareholders not personally liable for debt of corporation a. Piercing the corporate veil: make them personally liable 7. Corporation is a legal personality; it can sue and be sued a. Derivative and direct suits Dodge v Ford Motor Co. Corporations: goal is to maximize profit of shareholders. If directors withhold dividends for arbitrary reasons, they will be held liable. But otherwise courts do not get involved in ordinary business decisions AGENCY AND PARTNERSHIP 1. Agency Principles A. Liability in Contract Three Types of Authority: 1. Actual 2. Implied: agent s reasonable belief that he has authority from the principal a. It is based on past circumstances, nature of relationship/task, past course of dealings b. Totality of circumstances test Mill Street Church of Christ v Hogan: Bill Hogan believes he has authority to hire his brother to help him paint the church bc they suggested to him that he need an assistant. B s brother gets injured and church is liable Court imposes liability on church b/c he is the least cost avoider 3. Apparent: third party s reasonable belief that the agent has authority to act on behalf of the principal Restatement 27: conduct of the Principal, reasonably interpreted, causes the third person to believe that the principal consents to have the act done on his behalf by the person purporting to act for him

370 Leasing Corporation v Ampex Corporation: Joyce, third party, reasonably believes that Kays, A, has authority to enter into a contract on behalf of Ampex. Kays breaches contract and Joyce sues Ampex for liability. Holding: principal, Ampex, acted in such a manner that would lead a reasonably prudent person (Joyce) to suppose that Kays had the authority he purported to exercise Agent has authority to do thigns which are usual and proper in the business he is employed in 4. Inherent Authority Hidden Principal Problem protects the harmed third party Catch-all provision: Inherent agency power is a term used to indicate the power of agent derived not from authority, apparent authority, or estoppels but solely from the agency relation and exists for the protection of persons dealing with a servant or other agent Watteau v Fenwick: W leases hotel to Humbles. Humbles name is on the door. H is only allowed to buy beer and water but ends up buy cigars from P and does not sell. P sues W, the principal, for breach of contract. Issue: Ps never knew that Principle existed and yet they now sue him But P has no other form of recovery; so courts want to be fair and hold principle liable since he is the least cost avoider Rule (Restatement 194): a general agent for an undisclosed principal, authorized to conduct a transaction will subject the principal to liability in acts done on his account, if usual or necessary in such transactions even if forbidden by the principal to do such acts. 5. Ratification: a principal will be liable for agent s act if he ratifies the conduct Requires: 1. Intent to accept the results of the act 2. Full knowledge of the material circumstances 3. Material circumstances do not change; if you accept and then material circumstances change, there is no ratification 4. Must have opportunity to reject the benefits Ratification is a way to go back in time, create a contract when no contract existed at the time Ratification: my agent didn t have the right to enter this contract, but I am glad he did so. Ways to accept the contract: a. Explicitly say yes b. Implicitly reap the benefits accept by silence/inaction 6. Estoppel: (Restatement 8b) a person who is otherwise not liable for acts of a purported agent may be liable to persons who have detrimentally changed their position because of their belief that there was a legitimate agency if a. Principal intentionally or carelessly caused such belief, or b. Knew there would be reliance but did not take reasonable steps to prevent it

Hoddeson v Koos: women buys furniture from fake salesmen and sues store b/c they were careless to let an imposter operate the store . Principal-Agent-Liability Checklist 1. Look for actual, implied, or apparent agency 2. Look for ratification or estoppels 3. Look for inherent authority not as strong to prove Liability of the Agent 1. Issue of Undisclosed Principals Atlantic Salmon v Curran: agent is liable if he does nt sufficiently disclose principal D is a seafood wholesaler who buys fish from plaintiff under the name Boston Seafood but he really is the agent of Market Design. P sues D to get profits back. Agent is held liable for not disclosing the principal A is least cost avoider Rule: for partially disclosed principals, the principal is liable Liability in Tort 1. Principal is liable to third parties in tort actions if Master servant relationship + element of control Rule: Master is liable for torts of servant if: a. Committed in scope of employment b. Master has the right to control the physical conduct Rule: master is not liable for torts of an independent contractor Test: does the master have control or right to control? Factors: a. Duration of business relationship b. Control c. Risk of loss (the more risk is involved, the more control master wants to have) d. return Humble Oil & Refining Co master/servant relationship exists Humbles leases gas station to Schneider and tort occurs. Humble is liable because H retains control of everything: he pays for 75% of operational expenses, he sets the hours, he receives reports, he takes title to the products sold. The agreement can be terminated at H s will Hoover v Sun Oil - indep. Contractor relationship Sun Oil owns gas station and Barone operates it. Barone commits tort. Sun Oil is not liable because Barone sets his own hours, does not report to Sun Oil, Barone buys everything from Sun Oil but is in charge of day to day activities 3

To prevent master liability: limit control, not assume too much risk, not be able to revoke contract if independent contractor performs badly. If you can easily revoke, then it looks like you have a lot of control 2. Franchises Rule: if franchise contract so regulates the activities of the franchisee as to vest the franchisor with control within the definition of agency, the agency relationship arises even though the parties expressly deny it. Murphy v Holiday Inns: franchisor is not liable b/c all franchisor requires is standardization. It does not control day-to-day operations or take on financial risk. Miller v McDonalds: franchisee exercises apparent agency; third party reasonably believes that a McDonalds, owned by 3k restaurants, is the controlling principal. McD s represented that 3k restaurant is its servant or agent and caused third party to rely upon care or skill of the apparent agent a. Holding out by master b. Reliance by the third party Ways to minimize liability: sign on door independently owned and operated not require exact uniformity

3. Scope of Employment Conduct of servant is within scope of employment if it is a) of the kind he is employed to perform, b) occurs substantially within authorized time and space, c) is actuated at least in part to serve the master, d) if force is intentionally used by the servant, the force is not unexpected by the master Courts will find liability if servant commits crime while trying to serve the master in some way Manning v Grimsley: Cubs owners are liable for pitcher who throws baseball at heckling fan 4. Liability for Tort of Independent Contractor exception to usual rule Principal is liable for tort of independent contractor if: a. Master retains control of the manner and means of contractor s work b. Master hires an incompetent contractor (professionally and financially incompetent) Must prove that master was negligent in hiring an incompetent contractor c. Activity contracted constitutes a nuisance per se a. Inherently dangerous: indep. Contractor must be negligent b. Ultrahazardous: strict liability; no one has to be negligent Rule: liable for contractor who performs inherently dangerous work negligently Majestic Realty Associates v Toti Contracting: contractor is negligent while performing an inherently dangerous activity (Razing buildings) PARTNERSHIP Uniform Partnership Act: a partnership is an association of two or more persons to carry on as co-owners as a Characteristics: 4

1. 2. 3. 4. 5. 6.

Limited life span; death of partner can result in dissolution of partnership Unlimited liability; creditors may reach personal assets Non transferability of shares Flexibility of partnership structures Tax laws; taxed once All partners are agents of each other; every partner can bind the partnership in a K a. General partner: have unlimited liability/ gets to control much more b. Limited partners: limited liability but far less control

Kinds of partnerships 1. Limited: one ore more general partner and limited partners who are not personally liable for debts of partners 2. Limited Liability: all partners are protected form liability of torts that partnership commits, but they are still liable for contract acts 3. Limited Liability Company: all members participate in management w/o personal liability but it is also taxed like a partnership 4. S Corporation: corporation that is not double taxed Does a partnership exist? Look at intent and actions of parties. Totality of circumstances You are not a partnership simply by calling yourself one Intent: right to share profits, obligations to share losses If only one person has right to profits or suffers all losses, it is not really a partnership Uniform Partnership Act: Rules for Determining Existence of a Partnership 7(4): receipt of a person of share of profits in a business is prima facie evidence of partnership unless such profits were received by: a. Debt by installments b. Wages of an employee c. An annuity to a widow or rep of a deceased partner d. As an interest on a loan e. As consideration for the sale of a good-will of a business y Just b/c you get share of profits, it may be just part of regular compensation, and therefore you are not necessarily working in a partnership Other characteristics 18(e): equal rights in the management and conduct of business 9(1): every partner is an agent in the partnership 18(h): all decisions are made by the majority vote unless it is an extraordinary issue 9(3): extraordinary issues may be the disposal of goods will of business Maritn v Peyton: lender to a partnership is not a partner even though he has veto power and shares in profits Ways to avoid looking like a partner: 1) put in K prohibited actions instead of giving veto power, 2) put indemnification or limited liability clause 5

FIDUCIARY DUTIES OF A PARTNERSHIP Fiduciary Obligations of Agents and Partners DUTIES THAT AGENTS OWE PARTNERS Duty not to use agent/principal relationship as a means to unjust enrichment ex. Reading v Reading: British soldier smuggles goods across border and is forced to disgorge profits to the Crown b/c the only way he got this job was by virtue of his employment/wearing uniform if a servant takes advantage of his position and violates a duty of honesty and good faith to make a profit for himself, then he is accountable to the master test: if the use of principal s assets predominate in producing the profit, then it is a breach of fiduciary duty y The only duties a partner owes to another partner is due care and loyalty y Each partner is an agent of the partnership Rule: an act of the partner in the ordinary course of partnership business binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received notification that the partner lacked authority Duty to disclose opportunities related to the business General Automotive v Singer: Singer is employed by GA and does business opportunities on the side even though General Auto is not big enough to take on the clients that Singer has. There is K saying that Singer will devote his entire time, skill, labor and attention to said employment. Duty not to disclose trade secrets that the principal extended considerable time/effort to compile Town and Country House and Home v Newberry Ds work for dry cleaning service, then leave and start own business using principal s customer base Stealing customers away was breach of duty b/c customer list was very specific they had specific clientele and expended lots of energy to develop it Look at custom and industry standards: different industries are different (such as the law) Restatement 396: a. Agent has no duty not to compete with principal b. Agent has duty not to use or disclose trade secrets, written lists of names or other similar confidential matters given to him only for the principal s use DUTIES THAT PARTNERS OWE EACH OTHER y Duty to Disclose Partnership Opportunities to each other

Meinhard v Salmon: Salmon gets a lease on building for twenty years and enters into agreement with Salmon in which Salmon is passive investor and helps finance it. When lease ends, Salmon will undergo venture for another lease that includes the current building.

Salmon owes the duty to disclose an opportunity arising out of the incident of the partnership; he is a more active investor since he manages property and is more likely to have opportunities come to him, while Meinhard is passive Rule: must disclose to other partners things that are likely to be partnership opportunities UPA 103: Effect of Partnership Act; non-waivable provisions (a): relations b/w partners are governed by the partnership agreement (b): the partnership may not Eliminate a duty of loyalty The agreement may identify specific types of activities that do not violate the duty of loyalty, if not manifestly unreasonable All partners may ratify a specific act that otherwise would violate the duty of loyalty y Duty, if leaving a law firm, to give adequate notification and not take away clients unfairly Meehan v Shaughness, 1989: partners leave law firm (which is allowed) but they do so in an unlawful manner; the old partners have a right to send their solicitation to clients at the same time that departing partners sent theirs M and S sent form letters to clients before telling old partners that they were leaving and therefore incurred an unfair advantage y There is no breach of duty if a partner expels another partner in order to increase partner/client ratio as long as done in good faith, without a predatory purpose

Lawliss v Knightliner and Gray: alcoholic partner is fairly expelled from firm 1. Involuntary expulsion must be done in good faith 2. You can expel a partner for a bona fide predatory purpose, such as expelling someone in order to increase profits 3. Even if a partner dies/is expelled, the partnership may continue under a continuation provision FIDUCIARY OBLIGATIONS OF LLCS y Members of an LLC may compete as long as they give fellow partners an opportunity to take part

McConnell v Hunt Sports: M and H have partnership agreement that says partners may compete. A builder approaches Hunt to form an agreement for an arena, and Hunt repeatedly rejects offer. Building then approaches McConnell, who agrees. They form a separate agreement and now Hunt wants in on the deal. Non-compete clause: members may own an interest in any other business venture of any nature, including any venture which might be competitive with the business of the company PARTNERSHIP MANAGEMENT AND DISSOLUTION Rule: Ordinary business decisions require majority vote/ extraordinary decisions require unanimity

National Biscuit v Stroud: grocery store partners. Stroud tells P he does not want to buy any more bread from him, but Froud buys bread from P anyway. P sues partnership for price of bread Holding: Stroud is liable even though he did not approve of buying the bread Partnership Act 18(H): any differences arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners; but no act in contravention of any agreement may be done rightfully without consent of all partners Both Stroud and Froud started with authority to buy bread Froud doesn t have ability to stop this authorization since he does not have majority vote Summers v Dooley: S and D own trash collecting business. D is unable to work so he hires a replacement for himself. S hires a third employee even though D objects. S dues D to cover cost of the employee Holding: D is not liable to S; S did not have the majority vote to hire the third employee Unlike Stroud, there was no authority to hire a third employee to begin with Two tests of liability: 1. Internal partnership management: Dooley is not liable to S b/c S did not have majority vote 2. Third party agency theory: the whole partnership is liable to employee b/c employee reasonably believed that S had authority to hire him (apparent authority) y Entire partnership is liable to a tort that is committed by a partner in the course of ordinary business Moren ex rel Moren v JAX: woman works for pizza restaurant and her son s hand is cut off in the kitchen, where she is called into work. Woman s husband sues the whole partnership even though it is owned by his wife and her cousin he wants insurance money Rule: if tort occurs in ordinary course of business, loss falls on the partnership y Partnerships can contract around certain duties/non-disclosure of internal matters is not a breach of duty as long as no major injury occurs to the partnership Day v Sidley Austin: partner gets mad when a merger occurs and he is not aware that such merger will remove him from his position as Head of Office in Seattle. He claims firm misrepresented that no partner would be worse off by the merger and firm had duty to disclose all that was going to happen to him. But there is a partnership agreement that says all policy decisions will be decided by the Executive Committee Rule: non disclosure of internal matters does not count as a breach of duty as long as there is no major loss to the partnership. This is a decision covered by Executive Decision, which P agreed to. y Partners are liable for losses to the same extent that they share profits, unless agreed otherwise Exception: Kovacik v Reed: K starts business with 10K of his own money. R contributes labor/time. The business does not go well and K sues R to cover half of the losses Exception: you are only liable for what you put in so K is liable for money and R for his services. Assumes that person who did not put in money to begin with does not have much money to offer 8

Solution: 1. Parties need to put in K exactly what they will share 2. Should put a value on services rendered 3. New rule (UPA 18a): each partner is entitled to equal share of profits/losses G&S Investments v Belman partner dissolution Facts: Nordale is a drug addict and causes losses to the partnership. Other partners seek a judicial decree to dissolve the partnership. Shortly after, Nordale dies Issue: if partnership was dissolved when they sought a judicial decree to dissolve, then Nordale s estate is entitled to recover his fair market value. If the partnership continues with the death of the partner then estate gets only capital contributions (much less) Holding: court says filing a complaint to dissolve does not dissolve the partnership; Nordale s estate is only entitled to capital contributions (book value + share of profits) Rule: you must measure someone s partnership interest ahead of time with buy out provisions UPA 19 allows partners to continue the partnership business upon a partner s death, resignation, etc. Buy out formula: capital account + average of there years profits This means a partner gets a very low value of his partnership It incentivizes partners to stick around Summary: you can do whatever you want as long as you make it clear in the partnership agreement. If not clear, then the default rules apply (share equally in profits/losses, everything is decided by majority vote) NATURE OF THE CORPORATION Green v Market Corporate Machine Policy: a shareholder, even if a sole shareholder, cannot sue for losses that a corporation has incurred 1. Corporations are separate legal entities 2. Shareholder rights are only derivative; not judicially efficient to have many shareholder sue at once, do not necessarily know what is in best interest of corporation, divergence of interest b/w corp and shareholders and among shareholders themselves CORPORATE PROMOTERS: How does a separate legal person come into existence 1. Discovery 2. Planning (how much money is needed) 3. Assembling (corporate promoters sign leases, enter into KS) Promoters enter into Ks on behalf of corp that does not yet exist Documents: 1. Articles of incorporation: lays out framework, structure 2. By laws: easy to amend Rule: promoters are liable for contracts that they enter into on behalf of the corporation. To get out of liability, promoter can contract out of it: I promoter will not be liable on K Rule: once a corporation comes into existence, it is not necessarily bound to the contract that the promoter has signed. A corporation becomes liable once it affirms the contract 9

a. Must make an affirmative action of adopting the K b. Ratify by accepting the benefits, direct employees to perform the contract as if accepted Southern Gulf Marine Co. v Camcraft corporation by estoppels SGM negotiates a contract with Camcraft. Due to some procedural formality, SGM is unable to become a corporation so Camcraft decides to get out of contract claiming SGM is not a valid corporation. The contract is still held to be valid Rule: if you deal with a corporation, you are stopped from denying its existence unless your rights are prejudiced. You cannot get out of a K by invoking technicalities as long as major rights are not infringed upon. If contracting party did not lose a substantial right, contract must be enforced Ways to protect yourself: insist on individual guarantor by promoter, insist that investors of corporation post a pond. Put a capitalization requirement (assures that corp. will have enough money), write in provision for damages if corp is not formed, ask for progress payments, waive formalities PIERCING THE CORPORATE VEIL Going behind the corporation to get assets of the shareholders Going behind the corporation to get assets of other corporations that it owns Three Theories: 1. Enterprise liability 2. Respondeat superior 3. Disregard of corporate entity Walkovsky v Carlton, 1966 Carlton owns ten corporations, each of which own two taxi cabs. Each corp has minimum of 10K liability insurance. They are all operated out of a single garage. P is hit by a taxi and sues Carlton but he cant get that much money from one corporation alone so he wants to pierce the corporate veil Holding: not liable; insufficient evidence to show co-mingling of funds, lack of formalities, etc. Enterprise theory: Two or more corporations operate not as separate entities but integrate business resources to achieve a common purpose Factors: 1. Centralized record keeping 2. Unclear allocation of profits and losses 3. Intermingling of employees, no separate payrolls Rule: even if you can recover from entire enterprise, you cannot recover from shareholders individually Respondeat Superior plaintiff goes after the employer 1. Principle is liable for tort committed by his agent 2. Must happen within scope of employment 3. Must have certain amount of control or right to control (servants, not independent contractors) RS does not make much sense b/c no one would want to be manager/director 10

Disregard of Corporate Entity piercing the corporate veil Go straight to the shareholders to recover Test: 1. Unity of ownership and interest; corporate entity exists as a dummy Corporation and shareholders are the same 2. Not piercing the veil would sanction fraud and promote injustice a. Must show something more than just Plaintiff not being able to recover b. Must show skirting of legal rules, unjust enrichment, use of corporate faade to avoid responsibilities to creditors (purposeful wrongdoing) Factors: 1. No meeting of the board of directors 2. No real bylaws or recordkeeping 3. Co-mingling of accounts and funds 4. Lack of formalities, no indication of a separate legal personality Other factors: 1. Tort v contract (tort = unbargained for victims) 2. Whether stockholders have engaged in fraud or wrongdoing (knowingly siphoning out all profits of the corporation) 3. Whether formalities were followed (issuance of stock certificates, keeping minutes, holding meetings) Sea Land v Pepper Source classic veil piercing case Facts: P carries freight for PS. PS never pays the $87,000 freight bill b/c it has no funds. PS is owned by MArchese, who also owns five other entities. P sues Marchese and the five other entities, seeking to hold M liable for PS s debt and to satisfy any judgment with assets of other five corps. Holding: veil piercing allowed Little adherence to formalities, under-capitalization, co-mingling of personal and corp assets M used corporate entities as his playthings to avoid responsibilities to creditors he deliberately left them insolvent, he used corp money to pay personal expenses, avoided taxes, etc. FRAUD Tort v Contract: victims of tort have easier chance to sue b/c they did not enter into agreement freely. Contract is higher standard a. Suffer from contract point to lack of formalities b. Suffer from tort point to joint ownership, funneling money out of corporation. PIERCING THE CORPORATE VEIL OF PARENT-SUBSIDIARY CORPORATIONS Roman Catholic Archbishop of San Fran v Sheffield P wants to sue Archbishop under enterprise theory that Canons Regular and Archbishop, two subsidiaries of the Pope and Vatican, are alter egos of each other. Rule: in order to hold one subsidiary liable for acts of other another subsidiary there must be a co-mingling of funds between the sister subsidiaries, or plaintiff must present sufficient evidence to prove that they are not separate entities at all 11

Here, P is trying to sue horizontally hold one sub liable for the acts of another sub. This is not allowed because he cannot prove co-mingling of funds or that the two subs are really on and the same P cannot sue the Pope/Vatican b/c the Canons Regular did not have authority by parent to sell dogs In Re Silicone Gel Breast Implants Products Liability parent is liable for tort of a subsidiary The parent corp is liable for tort action of its subsidiary b/c there is sufficient evidence of substantial domination by the parent company. Rule: you can hold the parent liable as a shareholder but you cannot get personal assets of the shareholder Factors: 1. Bristol is one of three directors of both companies, but the other directors do not know they are actually the directors of the sub a. Evidence that the parent and sub are not that separated; do not hold separate meetings or minutes, no attempt to keep two entities distinct. Public is confused because parent puts its label on sub s products. 2. Consolidated tax returns (common) 3. Heavily involved in management of affairs (common) Rule: in parent-sub context, it is common that directors of parent will be involved in affairs of sub and have same tax returns, have veto power, request reports. BUT .parent cannot use sub solely for its own benefit and request that sub do things only in the interest of the parent Factors to pierce veil: 1. Sub has grossly inadequate funds 2. Parent pays salaries and expenses of the sub 3. Subsidiary receives no business except when it comes from the parent 4. Daily operations are not kept separate; parent does not observe basic corporate formalities such as separate books, etc. Rule: a parent corp is usually not responsible for obligations of its subsidiary as long as formalities are observed, public is not confused about who it is dealing with, the sub is operated in a fair manner with hope of making profit for the sub, and there is no manifest unfairness. Parent is not liable merely b/c there is a close relationship b/w the entities (Share directors, officers, lawyer/accountants, file same tax returns) Vicarious Liability: P must prove that subsidiary is liable and then establish that the parent should be automatically vicarious liable if certain conditions are met (co-mingling, misleading public, etc) Direct Liability: parent is so deeply involved in conducting the particular activities of the sub that it will incur liability Enterprise Liability: shareholder deliberately divides an enterprise into separate pieces; these subsidiaries are really the Children of the parent and are operated under a single purpose PIERCING THE VEIL OF AN LLC Frigidaire Sales Corp v Union Partners 12

Frigidaire contracts with Commercial, a limited partnership, M and B were limited partners of Commercial as well as officers/directors of Commercials general partner, Union Properties. Frigidaire sues M and B as directors of Union for Commercial s breach of contract Holding: even though general partners exercised control of Commercial, they were careful to keep two entities separate (held different meetings, minutes, etc. ) Frigidaire knew it was dealing with M and B as officers of Union, and not dealing with them in their individual capacity Rule: in must keep formalities separate limited partnership separate from the general partnership Rule: under certain circumstances you can pierce the veil of an LLC in the same way that you do a corporation Kaycee v Flahive: court treats LLC the same as a corporation; veil piercing is a common law doctrine that legislature intends to keep. But then what is the point of having an LLC if the veil can be pierced? The point of having different organizations is to give business forms a range of investor choices In LLC, there are no formalities to keep separate Not form LLC: want to create certainty for yourself and investors; LLC rules are less clear. Also, all the big name brands are corporations. Corporations are much more established than LLCs New Horizon Supply v Haack: D dissolves the LLC without paying money back to P. when P sues to get money back, D argues that the organization is an LLC and therefore she cannot be personally liable. Holding: there is not enough evidence to show that D controlled the company like a partnership and not like an LLC. There is no evidence showing that D organized and controlled the LLC s affairs such as it had no separate existence D is liable to the extent that she did not properly dissolve the LLC; did not notify creditors She took cash before creditors could get it; therefore she is liable for this amount ROLE AND PURPOSE OF THE CORPORATION Articles of Incorporation: to engage in any lawful business Charities A.P. Smith v Barlow Corp gives $1500 to Princeton U and shareholders say this constitutes waste; purpose is to maximize profits Holding: corps are free to give to charity as long as it does not give too much, and it is for a legitimate purpose 1. Society relies on corporations to be socially responsible 2. Corp creates good will, which helps corp in the long run Rule: charitable contributions are allowed unless the are a. Unreasonable amount (too much compared to net profits) b. Pet charity for CEOs interest and it has nothing to do with corp c. Given to a political organization d. No connection to corporate interests ALI 2.01(A): Corporation should have as its objective a view to enhance corp profit and shareholder gain. Subject to provisions of (b) (b): you must always follow the law, even if corp gain is not enhanced (b)(2): corp may take into account ethical considerations reasonably associated w/ the business 13

Schlensky v Wrigley: shareholders of Wrigley sue Wrigley owner for not putting up lights in the stadium and therefore creating waste by not making money on night games Rule: a corp. decision is enforceable as long as it is a) not fraudulent, and b) has a stated purpose to benefit the corporation, and c) might have a positive long term effect on the corp Holding: Wrigley can do whatever it wants it is not arbitrary or fraudulent Wrigley says no lights attracts people to stadium, makes it unique, enhances property value, etc. FIDUCIARY DUTIES OF OFFICERS, DIRECTORS, AND OTHER INSIDERS DUTY OF CARE Duty of care: no negligence Duty of loyalty: no self-dealing or fraud Rule: business decisions made upon reasonable information and with some rationality do not give rise to director s personal liability even if the decision turns out badly Reasonableness standard: directors are expected to perform their duties with the same care, skill, and prudence of lie persons in a similar position 1. Directors must make an informed decision; consider all materially information reasonably available to them Kamin v American Express: Ds decide to buy shares of a separate company and redistribute shares to shareholders rather than sell on the open market. By not selling on open market, Ds cost shareholder 8M in taxes. Shareholders sue Ds for making a bad decision that cost them a lot of money Holding: just b/c a decision turns out bad for the company will not make directors personally liable. a. Directors must consider the alternatives and make an informed decision b. There must be a rational explanation for decision they chose Business Judgment Rule (from 4.01(c): 1. Director must not have any private interest in the outcome that is different from the corporation s interest 2. Must make an informed decision 3. Must have rationally believed that judgment was in corporation s best interest What constitutes an informed decision: 1. Grossly negligent standard 2. Consider totality of circumstances: if board has to make decision in short period of time, then smaller amount of info gathered is sufficient to make an informed decision y Court is more concerned with the PROCESS then the outcome

Smith v Van Gorkom Van G is CEO and wishes to sell shares before retirement. He proposes to friend that shares be sold for $55, when price of shares on stock market are usually $38. Van G does not try to get any more offers for company and does not make any formal commission to value the company s shares. When getting Board s approval, Board was not sown merger agreement or any documents concerning value of the company. They relied solely on Van G s oral statement 14

Issue: did board exercise reasonable judgment in approving the deal? Holding: no Even though getting $55 per share seems like a windfall compared to fair market value, court says this process was negligent the board did not bother to find intrinsic value of company, relied only on oral statements, did not look at any written documents, did not try to solicit any other offers. The decision was made in 2 hours when there was no crisis or reason for such hurriedness. 141(e) says you can rely on good faith reports made by other officers, but court says you cannot rely blindly on a report and not ask certain question THEME: care more about process over result. Doesn t matter how you get to answer, it matters what you did to get there did you ask sufficient questions, disclose proper information, etc. Brehm v Eisner: board sues Eisner for hiring Ovitz and negligently making a severance package that rewards Ovitz for being fired without cause than actually fulfilling terms of the K. in the K, Ovitz gets the most money if he is terminated without cause. The board approves this package. Then Ovitz has a falling out and Eisner and the board decide he can be terminated without cause. Ovitz cashes in and board sues Holding: board did not breach duty bc it reasonably relied on compensation lawyer s advice. Relied on expert in good faith and never thought that he would be terminated without case. New Board is not liable either Rule: a board is not required to be informed of every fact, but rather is required to be reasonably informed VanGorkom: big decision such as selling company requires more deliberation; more inquiry Eisner: compensation package is ordinary business dealing, so requires less diligence and process y It is a breach of duty of care by not acting/omitting to act

Francis v United Jersey Bank: mother of two sons is director of a reinsurance company. Her two sons siphoned money from creditor and creditors sue director (mother). She is held liable for not keeping generally informed about what is going on in the company. if she asked questions and did not do anything, she might have been shielded by BJR you violate duty of care by not asking questions, keeping reasonably informed and up to date Rules for Insolvent Corporations: directors owe a duty to creditors first, then to shareholders, if the corp is insolvent. (in general, corp owes duty to shareholders first, then to creditors) Rules for avoiding director liability: 1. A director can absolve himself of liability if he informs other directors about the impropriety and/vote for a proper course of action 2. A director who is present at a board meeting and is presumed to concur in a corporate action taken at the meeting unless is dissent is enter into the minutes of the meeting Must dissent and enter it into minutes in order to avoid liability! y 15 Directors have a Duty to monitor their employees

In Re Caremark: employees engage in kickbacks that result in 25M of fines. Shareholders sue and a settlement is proposed. The court must approve settlement and shareholders sue to not have it approved. issue: should the settlement be approved? Holding: yes a. Board cannot be charged w/ wrongdoing for assuming honesty and integrity of employees b. Corporation had a committee charged with overseeing corporate compliance Rule: a corporation must have a monitoring program in place that is reasonable; look at industry standards y Board does not have a duty to monitor the personal activities of its directors

Beam v MS: MS is public face of her company and she engages in insider trading which causes the stock price of MS to plummet. Shareholder sue board for failing to monitor her personal affairs Holding: board only has a duty to supervise activities that arise within corporate affairs, no duty to monitor personal life of a board member. Way to protect yourself: put in contract that MS cannot engage in certain activities b/c she is face of a public brand and therefore undergoes more scrutiny. DERIVATIVE V DIRECT LAWSUITS Test: 1. Is the harm to the individual plaintiff or to the corporation? 2. Who recovers the damages? Derivative - Posting bonds: 1. Avoid nuisance suits by small shareholders (but class actions do not have to post ponds) 2. Too many suits waste excessive time, energy, and money 3. If there is a problem, the board should fix it internally without resorting to a lawsuit Rules about making demand: 1. P makes demand on board b/c P as a shareholder does not have standing to sue the corp. 2. D rejects it 3. P responds that rejection of demand was wrongful; court will apply Business Judgment Rule BJR is hard to overcome Rule: once you make a demand, you have waived your right that it should have been excused So if demand is rejected, you cannot argue that demand should have been excused Plaintiffs are better off trying to first argue that demand should be excused Board s response to demand requirement: 1. It will usually say this lawsuit is not in the company s best interest 2. It can appoint a Special Litigation Committee to analyze the situation 3. Sometimes it will let shareholder follow through with the suit, if it is a small matter y Direct Action P argues dilution of his voting rights


Eisenberg v Flying Tiger: P is a shareholder of FT, which goes through a series of reorganizations and mergers into smaller holding companies. P claims his voting rights have been diluted as a result of these mergers. D tries to dismiss suit b/c bond was not posted but court says no bond was required b/c this was a direct action Direct: dilution of voting rights is an injury to the plaintiff individually; recovery goes to P not to corporation (P gets voting rights back). No demand is required for direct shareholder sits Derivative: if P had claimed that Flying Tiger had brached its duty of loyalty by reorganizing in a self-interested way. Then P would have to post a bond. Grimes v Donald Delaware Demand Requirement Board of DCS executes employment agreement with CEO in which he gets all sorts of compensation benefits and largely unfettered control of the corporation. P sues, saying that CEO is paying himself too much money. This is a derivative action and P says demand should be excused When a demand may be excused under Delaware Law 1. Majority of the board has a material or financial interest 2. Board is incapable of acting independently; dominated or controlled by an interested director 3. Underlying action is not a valid business judgment rule transaction Majority board interest must be at stake: if 3 out of 7 are interested, this is not majority Marx v Akers, 1996 NY Demand Requirement New York Rule: demand is excused because of futility when a complaint alleges with particularity that a majority of the board of directors is 1. Self interested in the challenged transaction (self interest in transaction at issue or loss of independence b/c director is controlled by an interested director) 2. Board of directors did not fully inform themselves about the challenged transaction to the extent reasonably appropriate under the circumstances. 3. Challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors NY standard: harder to get demand excuse NY prong about director self interest is broader talks about self interest and control NY prong about business judgment seems to indicate that court will take a deeper look inot the reasonableness of the business judgment y Special Committees looking into the Demand Requirement must not be self-intersted

Auerbch v Bennett: P brings derivative suit against corporation s directors, independent auditors, and the corporation for seeking unfair bribes and kickbacks. The board creates a special litigation committee and appoints three disinterested directors to the committee who joined the Board after the bribery occurred. The committee thinks it is in best interest to dismiss the suit Holding: 1. The committee formed is acceptable and made a proper decision o dismiss the suit 2. The committee was disinterested, not dominated and controlled 17

Rule: as long as the committee is disinterested, the court will not look into the substantive decision it makes; it cares only about the process. But court will take into consideration public policy, such as fraud, embezzlement Delaware 141(c)(2): the court will judge whether the litigation committee is in fact independent or whether the committee conducted a sufficient investigation, but it will not judge the substance of the committee s decision Zapata Corp v Maldonado: due to public policy concerns, the court decides to overturn the special committee s decision to dismiss the lawsuit. It looks more at the substance of the decision than the process balancing test: 1. Shareholder s power to bring important litigation v corporation s right not to be unfairly trampled by excessive litigation 2. Court may inquire on its own into independence/good faith of the committee In re Oracle Corp: Special Litigation Committee is held not to be independent enough bc they have strong ties to the company (Stanford professors one of them was a professor to the director, the company donates lots of money to Stanford) Problem for Oracle is that they want smart people to be on committee and these people are good for it, but they have too many ties to the company DUTY OF LOYALTY Delaware Corp Law 102(b)(7): No provision shall eliminate the liability of a director: i. For breach of the director s duty of loyalty to the corp. or its shareholders ii. For acts or omissions not in good faith which involve intentional misconduct or a knowing violation of the law iii. For any transaction from which the director derived an improper personal benefit Delaware Corp. Law 144 Interested Directors: (a) No contract or transaction b/w an interested director is void as long as 1. The material facts of the contract and the material facts of the director s self interest are disclosed to the board of directors, and the majority of the board in good faith authorizes the contract 2. Or the director proves that the contract/transaction is fair Bayer v Beran, 1944 D uses his wife to sing in advertising campaign. P alleges that D s purpose was not to further corporate goals but rather to help further wife s singing career. Court holds that this is a self-interested transaction and D has burden to prove entire fairness. D is able to prove it is fair b/c the wife is a good singer in her own right and D was going to do an advertising campaign anyway Lewis v SL&E directors on both side of the transaction 18

Ds are directors of two companies, SLE and LGT. SLE leases land to LGT for ten years and contract is renewed at same cheap price while land is getting more valuable. Shareholders of LGT sue b/c they are losing money from cheap lease Rule: 1. Must disclose material facts and have it ratified 2. If not approved, D has burden to prove entire fairness 3. If approved (valid sanitization), P has burden to overcome business judgment rule CORPORATE OPPORTUNITY DOCTRINE Rule: an officer or director cannot take an opportunity that the corporation itself might accept and if the opportunity came to the officer/director by virtue of his position ( a director agrees to place the interests of the corporation before his/her own in appropriate circumstances ) Broz v Cellular director did not seize a corporate opportunity Facts: Broz is a member of a board of CIS, which is having some financial difficulties. A broker comes to Broz and tells him about a license. Reps at CIS say they are not interested, so Broz personally bids on it and outbids PriCellular, which ultimately buys CIS. CIS then sues Broz for seizing a corporate opportunity Delaware Corporate Opportunity Test A director is obligated to bring an opportunity to the corporation IF 1. The corporation is financially able to undertake it 2. It is in the line of the corporation s business 3. The corporation has an interest and expectancy 4. The self-interest of the officer or director will be brought into conflict with that of the corporation y Must satisfy ALL four prongs 5. A fifth factor if director is approached in his individual capacity or in his corporate capacity (only got the offer by virtue of his position of being director) Court says Broz did not seize a corporate opportunity If Broz did seize a corporate opportunity he would have to disclose to the board and have a majority approve it (Sanitize). P would then challenge sanitization and have burden to overcome Business Judgment In Re Ebay Shareholders Litigation: in return for doing underwriting work for Ebay and hoping to retain Ebay as their client, GS distributes IPOs to Ebay directors/officers, which they can sell for a profit. Shareholders allege that these IPOs should have been distributed to the entire company Satisfies four factor test: investing in securities in line of business/had interest and expectancy Remember: if a majority of disinterested shareholders had approved of the transaction b/w Ebay and GS, then the corporate opportunity is sanitized and plaintiff must overcome business judgment rule. P can argue that by accepting IPOs from GS, Ebay is submitting itself to continue working with GS indefinitely (may not be a good thing) Rule: if you are unsure, always present a corporate opportunity to the board and get it formally sanitized (approval by majority). It is not enough to tell boss about it and get the ok (this is informal approval) 19

DUTY OF CARE DOMINANT SHAREHOLDERS Sinclair v Levien: Sinclair is holding company that owns 97% of stock of Sinven, its subsidiary. Shareholders of Sinven bring derivative suit and claim D breached duty by a) causing Sinven to pay massive dividends, b) usurping corp opportunity to develop oil fields, 3) not allowing Sinven to pursue contract claim Rule: controlling shareholders owe a duty to minority shareholders Rule: the majority shareholder cannot benefit to the exclusion of the minority shareholder. If majority benefits, D has burden to prove entire fairness 1. If D is challenged by minority shareholders b/c they claim that D benefited to the majority of P, D must overcome entire fairness standard Zahn v TransAmerica: TransAmerica owns 80% of Class B stock. It does not tell company about valuable asset, and thus cause Class A shareholders to call in shares rather than liquidate shares and earn more money. Class A shareholders sue for breach of loyalty; not disclosing material information. Rule: dominant shareholders cannot benefit to the exclusion of the minority; Class B holders breached duty But in reality board of directors owe stronger fiduciary duties to shareholders who don t have voting power (class B), so it doesn t make all that much sense that duty should be owed to A rather than B Wheelabrator: Waste owns 22% of WTI and wants to increase its ownership, get another 33% and merge companies. There are four Waste directors on WTI board. All 11 directors approve and majority of shareholders approve of merger. Plaintiffs, shareholders of Waste, sue on several grounds. Holding: b/c Waste is not Dominant Shareholder, and b/c transaction was sanitized, P has burden to overcome BJR. You apply entire fairness standard when P is challenging the action of a controlling shareholder Rule: in a parent-subsidiary merger, the standard of review is ordinarily entire fairness. Where the merger is conditioned upon approval by a majority of the minority stockholder vote, and such approval is granted, the standard of review remains entire fairness, but the burden of demonstrating that the merger was unfair shifts to the plaintiff. INSIDER INFORMATION Federal Securities Act: 1933: deals with the primary market; when issuer of securities sells them into market for the first time 1934: deals with secondary market (selling shares b/w investors on the NYSE) Three ways to be liable 1. Insider (directors, employers, etc) 2. Tippee get info from insider, aware of a fiduciary duty, insider benefits 3. Misappropriation duty to source of information Goodwin v Agassiz, 1933 P, shareholder of mining company, sells shares of mining company to Directors, D. D know about theory that there might be some copper deposits on land. If there are deposits, the directors want to buy the shares and re-sell when the price goes up. 20

Holding: D not liable to P b/c theory of copper deposits is speculative, not totally certain. Plus, directors do not have duty to make sure shareholders always make sound investments You don t have a duty to disclose a nebulous theory Directors were not dealing with shareholder personally dealt with P indirectly Might be different if director personally sought out the shareholder SEC v Texas Gulf: officers violate Rule 10b-5 b/c they mislead the public about oil deposits on land that will make shares more valuable. They hide fact that they are buying land then issue press release to squash rumors that there is oil there. Finally, as the news or oil goes public, directors do a lot of buying and selling Rule 10b-5: it shall be unlawful for any person, directly or indirectly, by the use of any means of instrumentality of interstate commerce: y Make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading Holding: D s are held liable for trading on material, non-public information It is unlawful to trade in possession of material, non-public material information while you owe a duty to someone Test for materiality: probability o event occurring + magnitude of the event Standard for materiality: what a reasonable investor would think is important Court looks at actions of directors to see what they did when they got the information; fact that they bought and sold indicates they thought it was material Equal access: anyone who has access directly or indirectly to information intended to be available only for a corporate purpose and not for the personal benefit of anyone may not take advatange of such information knowing it is unavailable to those whom he is dealing. Rule: analysts may not trade on insider info (unless they wait for quarterly reports to be issued) but they can pass on insider info w/o violating duty. If you choose to trade, you must disclose. Silent and not trade is ok Dirks liability of a tippee Dirks is securities analyst who hears about wrongdoing of Equity Funding from Secrist (insider)...Dirks investigates and tells some people, and they end up selling shares. Dirks is not liable as a tippee b/c Secrist, the insider, does not benefit Court does not want to penalize someone who is trying to overcome wrongdoing Rule of Tippee Liability: Tippee is liable when he participates with the insider in a breach of fiduciary duty; insider discloses information to tippee for his personal benefit, and tippee knows or should know that insider has breached his duty. Insider must benefit either financially or personally Defenses to Insider trading 1. Insider did not benefit gave the information inadvertently (limo driver overhears) 2. Info as speculative or not material 3. Line of information was severed Martha Stewart case 21

What kind of benefit? Usually it can be anything tangible, such as a gift, any kind of personal benefit, not just financial Ex. merger negotiations b/w CEO 1 and CEO 2. The deal falls through and CEO 2 trades on inside info. CEO2 is not liable b/c CEO 1 does not benefit Constructive insider: lawyer working for company and you make a trade based on material non-public info from the company. You are a constructive insider and agent, owe duty to that company. Also, you owe duty to law firm under misappropriation theory. If you tell law firm you are going to trade and they agree to that, then it might be o US v O Hagan: Misappropriation Theory D is partner of law firm and works on deal with Grand Met. Grand Met is working on tender offer to buy Pillsbury. D starts buying options of Pillsbury. D owes no duty to Pillsbury only a duty to Grand Met and the law firm. D is held liable b/c he owes duty to source of information, the law firm Misappropriation theory: breach of duty owed to the source of the information As long as D told law firm he was trading, then is not liable. Not have to disclose to public O Hagan might be liable under 14(e), which imposes liability on a person in possession of material non-public information in connection with a tender offer any person who has taken a substantial step in connection with a tender offer DISTRIBUTION OF POWERS BETWEEN SHAREHOLDERS AND MANAGERS 1. Shareholders are residuary owners 2. Potential for control exists through voting for directors Must vote to approve for merger, amendments, sale of substantial assets, etc. 3. Voting power is often not realized (except in mergers and takeovers) Stroh v Blackhawk Holding Corp, 1971 Rule: shares with voting rights are valid, even if there are no economic rights A corporation may structure voting rights as it sees fit so long as the rights are not changed midstream a. Some shares can have 1 vote, others can have 8 Reason to structure shares in different ways: retain control without putting too much money in; get someone else to come on board and take risks b. Cumulative voting: make sure minority voters get at least one elected official (Class A gets 900 votes and Class B gets 600. If Class B puts all 600 votes on one candidate, that candidate will be on board) c. Class voting: certain kinds of decisions need approval from each class of shares FEDERAL REGULATION OF THE PROXY SYSTEM Regulation of the proxy system is governed by federal law Section 14 of 1924 SEC Act 14(a): SEC can make all reasonable regulations for governing the proxy process 1. Applies only to public companies 2. Public companies must have 500 shareholders and asset threshold of 10M 3. Must provide all voters with proxy statements, which lays out relevant information 22

PROXY WARS Rule: the management may use corporate funds to pay for proxy materials. The corporation will reimburse incumbent directors if purpose is to perform shareholders about policy differences and is not using money for his/her benefit and not spending excessively. 1. Corporation will reimburse for proxy materials 2. Must use funds appropriately to highlight policy differences Levien v MGM: corporation reimburses directors even though they hire PR people, lawyers, etc, to win proxy fight. Management and the insurgents are clearly fighting over policy issues Rosenfeld v Fairchild insurgents reimbursed if . 1. They win the proxy war 2. Expenses are reasonable (in good faith fighting over policy decisions) 3. Shareholders ratify the agreement Primary goal of this proxy fights is to make sure that shareholders are well informed Alternative to proxy fights: buy up a lot of shares PRIVATE REMEDIES FOR PROXY VIOLATIONS- 14(a) Material Omissions Private Actions for Proxy Rule Violations SEC Rule 14a-9: no solicitation subject to this regulation shall be made by means of any proxy statement which is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make these statements therein not false or misleading y Considered a derivative action; b/c benefit to corp. to have well informed shareholders JL Case Co v Borak: P claims proxy materials are false and misleading Rule: court recognizes a private right to sue. Purpose of statute is to protect investors; it is easier for investors to bring cause of action than to SEC to investigate all proxy filings Rule: must prove causation + damages Mills v Electric Auto Lite Co Merger b/w AutoLite and Morgenthauler. M does not disclose that he also sits on board of AutoLite (so there is a conflict of interest). P sues for non-disclosure of material information in the proxy statements. Causation: Ps do not have to prove that they definitely would have voted differently had they known about this fact but that the 1. There was an material omission and 2. Solicitation of proxy votes as an essential link to the accomplishment of the transaction b/c M could not have gotten merger approved without 2/3 vote, the solicitation of votes was an essential part to merger transaction test for materiality: old standard: defect is of such a character that it might have been considered important by a reasonable shareholder 23

new standard substantial likelihood that reasonable shareholder would consider it important in deciding how to vote (omitted fact assumes actual significance in the deliberation) Seinfeld v Bartz, 2002- materiality standard codified A fact is material if there is a substantial likelihood that a shareholder would consider it in deciding how to vote In this case, court says that when proposing new executive compensation and omitting to disclose options is not a material omission. Not a good holding. 1. It is sufficient to establish a substantial likelihood that under all of the circumstances, the omitted fact would have assumed actual significance to a reasonable shareholder SHAREHOLDER INSPECTION RIGHTS Issue: when can a shareholder proposal be excluded from the proxy statements? SEC Rule 14a-8: tells you when a company must include the shareholder s proposal in its proxy statement Shareholder must meet certain procedural formalities, such as making it 500 words or less Generally, as long as procedural requirements are met, a shareholder can submit a proposal However, there are exceptions listed (4): personal grievance if the proposal relates to the redress of a personal claim or grievance against the company, or it if its is designed to result in a benefit to you (5): relevance (not significantly related to the business) If proposal relates to operations that account for less than 5% of the company s total assets at the end of its most recent fiscal year, and less than 5% net earnings, etc .and is not otherwise related to the company s business. (6): absence of power/authority: if company lacks power to implement the proposal (7): if it deals with matter relating to company s ordinary business operations Lovenheim v Iroquois Brands Not Significantly Related Exception Even though foie gras production accounts for less than 5% of profits/assets, P is allowed to submit proposal on more humane ways to produce foie gras be/c it has a social and ethical impact It falls into the otherwise significant exception proposal is allowed 1. Burden is on corporation to sow it is not significantly related 2. It does not necessarily have to meet economic threshold Rule: 1. Shareholders can make recommendations; they cannot force the board to do something or invade into board s decision making area (can only make recommendations through committees/studies) NYC Employees Retirement System v Dole Foods Company P requests proposal to conduct study on health care coverage. D wants to exclude it on grounds that it is a) an ordinary business matter, b) corp lacks power or authority, c) not significantly related to the business Holding: 1. This is not an ordinary business matter health care is a major policy decision Distinguish b/w major policy decision and mundane matters 2. Is not not significantly related health care comprises more than 5% 24

3. Rejects beyond power to effectuate defense Austin v Con Ed ordinary business matter and personal grievance exception Ps are employees of Con Ed and want to include in proposal that retirement should be allowed after thirty years of service, not when they are 65. Calculate years of service as age + years of service Holding: pension plan is a mundane issue, can be decided by collective bargaining. It is not a major policy decision or a pressing moral/ethical issue Personal grievance claim: employee is fired and wants to be reinstated, goes about it by making a proposal in the proxy statement not allowed! Burden of proof: burden is on the corporation to prove that one of these exceptions is relevant; proposals are important b/c it is only way for shareholders to effectively communicate with each other REQUESTING SHAREHOLDER LISTS Rule 14a-7: proxy solicitation shareholder s rights to get access to a proxy list Rule: you cannot use proxy to propose your own set of directors for election ( no proposal can relate to an election for membership on the company s board of directors ) You can use a proxy 14a-7: a registrant who wants to make a proxy solicitation must either get the board of directors to mail copies of any proxy statement to all security holders, OR deliver the shareholder list to the person wanting the information companies will always choose to mail shareholder lists Crane v Anaconda: Crane is Illinois Corp and proposes tender offer for Anaconda. A does not want tender offer and denies C access to shareholder list. C buys some shares in A and requests shares again Holding: C can get access to the list b/c he has a Proper Purpose C has procedural requirements: be shareholder for certain amt of shares, file affidavit Company has burden to prove that C wants list for an improper purpose A tender offer is a proper purpose b/c it greatly impacts the corporation Choice of law: the state in which the requesting shareholder lives. So even though companies are incorporated in Illinois and MN, the shareholder lives in NY, so NY law applies Proper purpose: tender offers Improper: unrelated matters like pet projects and politics Rule: 1. Shareholder is presumed to be able to get shareholder list; burden is on D to prove an improper purpose 2. If shareholder wants any other list (like minutes, reports), burden is on P to prove a legitimate interest 3. A director mya have right to examine other lists reasonably related to his position as director Sadler v NCR using an agent to get the shareholder list for you 25

ATT wants to make tender offer for NCR and uses one of NCR s shareholders, Sadler, to request proxy list Agreement b/w ATT and Sadler is a valid agency relationship; but if Sadler breaches agreement and changes his mind, court will not enforce the agreement Proper purposes: stock splits, tender offers, etc. Improper: want list for own personal benefit (sell cars instead of shares) If shareholders want something other than shareholder list, such as records relating to employment practices, burden is on the shareholder to prove that it is for a legitimate business purpose CLOSELY HELD CORPORATIONS Characteristics: 1. Very few shareholders 2. Cannot re-sell shares on open market 3. Majority shareholders play large role in management 4. Minority shareholders want to be able to retain some control and do this by a. Voting/pooling agreements b. Voting trusts c. Classified stock Valid voting agreements: 1. A and B are the only two shareholders of a company and they agree to vote for each other as directors as long as the agreement lasts 2. A owns 60% and B owns 40% and they agree to always vote as a unit, so B is assured he will never get outvoted Invalid agreement: 1. Shareholders cannot make agreements on what the board of directors can do. An agreement in which two shareholders of a corp. agree that one of them will serve permanently as President is invalid (this decision is left up to board of directors) Ringling v Ringling: Ringling, Haley, and North are three shareholder of a corp. they agree to consult and confer with each other and vote their shares on any issue. If they cant agree, then they must submit to an arbitrator. Later, Haley and Ringling disagree. The arbitrator votes Haley s votes for him, even though Haley wants to vote for someone else. Holding: the agreement is valid but the arbitrator was not allowed to cast the votes for Haley. The court says Haley s votes do not count. So Ringling does not really win ; what Ringling wants is for Haley to vote in the same way that Ringling does. Classified stock/weighted voting: corp sets up two or more classes of stock and gives classes different voting powers or financial rights. A minority stockholder may be given voting rights equal to those of the majority even though he does not have equal financial rights. Rule: shareholders can limit their discretion as shareholders (agree to vote for certain directors) but they cannot agree to restrict their discretion as directors 26

Shareholders cannot make agreements that restrict the board s discretion

Stoneham v McGraw: Stoneham is majority shareholder and McQuade and McGraw are minority shareholders. They agree to keep each other in office as directors with specific salaries; one will be president, the other treasurer, etc. later, McQuade is ousted as director and treasurer and he sues Holding: agreement not valid bc stockholders cannot place limitations on the power of directors to manage the business of the corporation Public policy: directors should use business judgment to do what is best for the corporation You cannot decide ahead of time what to do as directors But in this case there are only three shareholders; minority can sue for breach of duty What McQuade could have done: make an employment contract with big severance package if they fire him/ if they fire him, then they must pay him some money Clark v Dodge softened position C owns 25% of corp and D owns 75%. They are the only shareholders; sign agreement in which D will vote for C as director and pay him of income as long as he remained faithful, efficient, and competent. C also knows about secret formula and D wants him to tell him what it is. Eventually D fires C and C sues Holding: agreement is valid All shareholders were represented (two shareholders two signed) No minority interest or creditor was injured as a result C could be discharged for cause if he was inefficient, incompetent there was a wy out Rule: in order for a shareholder agreement to remain valid, it must not 1. Harm creditors, the public, or non-consenting shareholders 2. Must not involve a large variance from the rule that a corp s business should be managed by the board 3. May require that all shareholder consent; or that the plaintiff attacking the agreement had previously consented Galler v Galler: two brothers each own 47.5% of the stock. They sign agreement in which they agree to pay certain dividends each year and pay specified pension to widow in event that one should die. One brother dies and the other refuses to carry out agreement. Agreement is suspicious b/c it is for undefined duration, requires dividend payment which is usually protected by business judgment. Holding: Agreement is upheld b/c it does not harm any minority interest, there is no injury to public or creditors, and agreement does not violate a clear statutory provision Remedy: specific performance; wife get past payments and is put back on board of directors, but this puts her in a deadlock with the surviving brother. Better remedy is to value your interest in the company Ramos v Estradas: company makes agreement to vote shares according to the majority and failure to do so will require that person to sell shares back to the company. D defects and does not vote in majority and P sues, asking for shares to be sold 27

Holding: agreement is valid b/c there was a legitimate purpose to enter into the agreement, parties wanted to ensure power to control corporation through voting, and forced sale provision is not unconscionable b/c parties negotiated for the deal on equal terms Remedy: D must sell shares and is no longer part of the board; this is good b/c avoids more conflict CLOSED CORPORATIONS ABUSE OF CONTROL Generally: shareholders do not owe duty to other shareholders unless you are majority shareholder and have control over the corporation. Closely held corporations: all shareholders owe a duty to each other (treated like partners) (MA) Wilkes: Wilkes enters into closed corporation with two other shareholders. A fight erupts and they kick Wilkes out of his position as director and cause him to lose his salary. Wilkes sues saying they had an understanding that he would be director and make money, even if no official contract Holding: other shareholders freezed out Wilkes in bad faith MA court is sympathetic to these claims!! Test for Breach of Duty of Loyalty in a Closed Corporation 1. Majority shareholder must prove that it acted for a legitimate corporate purpose 2. If majority proves legitimate corporate purpose, minority shareholder can prove that there was an alternative that would have caused less adverse effects 3. Court will balance the purpose vs means y Must differentiate b/w duty of loyalty to a shareholder and to an employee

(NY) Ingle v Glamore: Ingle is an employee who is able to buy shares of stock. There is an agreement that if Ingle stops being an employee for whatever reason, Glamore can buy back the stock. Glamore fires Ingle and buys back stock for $96,000. Ingles sues for breach of duty of loyalty Holding: there is no breach of duty b/c Ingle was primarily an employee and got the stock through his status as an at-will employee; no duty to employees. There was a clear contract that if Ingle stopped working, then Glamore could buy back shares, and Ingle accepted fair price for his shares. Rule: there must be special relationship in which shareholders view each other as partners in order for there to be a special duty FREEZE OUT: minority shareholders attempt to exclude the minority from 1. Economic benefits of the company 2. From participation in corporate decision making process (ex. not pay dividend, not employ a minority holder, not pay anything other than ordinary salary) Majority shareholder owes a fiduciary obligation to minority shareholder Test: 1. Majority s decision will be upheld if it is a legitimate business purpose 2. Purpose cannot be achieved by a less harmful action or alternative


Employee v shareholder status: depends on a party s reasonable expectations did they view employment as means to the stock or shareholder status as primary means of realizing an investment? Sugarman v Sugarman look at totality of circumstances to determine if there is a freeze out Majority shareholder does things that individually might not constitute a freeze out but when taken collectively it is determined to be a freeze out lots of little things add up: denying employment to his brother, refusing to pay dividends, draining company of earnings by paying himself excessive compensation, overpaying his father, etc. (MA) Smith v Atlantic Properties minority shareholder owes duty to other co-shareholders Here, a minority shareholder is deemed to owe a duty of good faith b/c he has veto power over corporate actions and unreasonably exercises his veto power. The other three shareholders want to pay dividends but he wants to hold onto the money and reinvest. As a result the company is taxed a lot. Court says this is irrational and he is liable for making the company incur huge taxes. Court says D exercised veto power for selfish reasons, out of dislike for the other shareholders, not for a valid business purpose. D has to reimburse company and to have dividends paid. He is still on board of company so tnesino still exists This is another MA case: more likely to find shareholder fiduciary duties Issues: 1. What are the expectations of the party at the outset of the relationship? 2. Is right to share in profits something that is paramount? 3. Or are you just an employee and sharing in profits is part of salary? Jordan v Duff and Phelps Jordan sues company for not telling him about possible merger which will make shares a lot more valuable and would prevent him from leaving the job or at least waiting to cash in. does the company owe a duty to tell him about increase in share value? Holding: the company had a duty to disclose the merger activity; breach of Rule 10b-5. Problem is proving causation; would P have stayed even if he knew about merger, and then merger deal collapsed, but then stayed for a full year longer? Rule: even though P was an at-will employee, an employer cannot take opportunistic advantage of the employee P had an expectation that he would not be randomly fired form his job Pedro v Pedro: brother, who owns equal shares of the company, is fired and loses salary bc he tries to investigate into accounting discrepancies. He sues b/c he reasonably expected that he would stay employed during his lifetime. Remedy: court awards him 75% of book value (per agreement) plus the difference b/w market value and the 75%....for breach of fiduciary duty. He also gets wage compensation for life bc he reasonably expected to be employed Rule: courts have equitable authority to protect the rights and reasonable expectations of minority shareholders. The primary expectations include having an active voice in management of the corporation and input as an employee. 29

TRANSFER OF CONTROL Corporations: freely transferrable shares Closed corporations: no open market; shareholders want a guarantee that they will stay together and not be dominated by strangers Solutions: right of first refusal (if someone wants to sell stock, minority shareholders have right to buy it first) Purchase Transactions 1. Buy directly from shareholders (buy stock from them) 2. Purchase assets (shareholder approval is necessary) 3. Merger (shareholder approval necessary) Frandsen v Jensen-Sundquist Agency: court construes right of first refusal narrowly; does not let Frandsen exercise his right b/c the effect of transaction does not effect F s right as a minority shareholder. Two companies merge but the majority shareholders are the same. Purpose of right of first refusal is to make sure company is not sold into stranger s hands; this is not the case here Zetlin v Hanson Holdings: minority shareholder wants to be paid the same premium price that majority shareholders get when they sell their shares. Court says that a controlling shareholder can sell his share for a premium price b/c that is the nature of having majority shares you have more control; therefore you should be able to get more money for your shares Rule: when you sell a controlling share, you are giving up a lot of control and therefore you are entitled to a bigger price. A controlling shareholder has the right to take the entire premium for himself and does not have a duty to distribute to minority shareholder unless there is reason to believe that the purchaser is doing something fraudulent or has a history of looting companies. MERGERS Theme: form over substance; you can accomplish the same transaction using different legal frameworks 1. Statutory Merger a. Boards of both companies negotiate a merger agreement; mergers trigger appraisal rights b. Appraisal rights: shareholders who do not want to merge can sell shares back to company for a fair market price 2. Assets Sale Company A buys all assets of Company B Company B gives share in return Selling assets the shareholders must approve No appraisal rights 3. Purchase of Stock a. Company A tells Company B we want to purchase your stock b. Do not need to get board s consent; usually a hostile takeover/tender offer Farris v Glen Alden- de facto merger doctrine 30

Court treats an acquisition as a merger even if it has followed a separate route List wants to merge into Glen Alden Glen Alden buys up all of List s assets and List gets Glen Alden s shares Therefore, Glen owens all assets of both Glen Alden and List, but List becomes majority shareholder Plaintiff of Glen Alden says this is like a merger and wants to exercise his appraisal rights The court lets him do this Why? PA law says that there are no appraisal rights when a company buys a lot of assets But Court says 9.08 statute is not contemplating a situation where essential nature of the company is changed The essential nature of corporation so changes that you are now a shareholder of a corporation of an entirely different entity, then we want to give you the option to get out We do that by giving you cash for your shares

Hariton v Arco Asset for Stock Sale not treated like a de facto merger Arco sells all of its assets to Loral Loral gives all of its shares to Arco Arco liquidates and distributes Loral s to its shareholders Holding: shareholders do not get appraisal rights Delaware law: shareholders of a company that sells all of its assets (Arco) do not get appraisal rights, and shareholders of a company that dissolves and distributes its assets do not get appraisal rights either There is specific statute that deals with procedure of sale of assets no appraisal rights If there are no appraisal rights, what else can minority shareholders do? 1. Sell shares 2. Make derivative lawsuit (directors are giving things away for less than fair market value) 3. But if there is a liquid market for shares, then you don t really need appraisal rights Weinberger v UOP, 1983 Signal owns 50.5% of UOP. 4 directors of UOP are also directors of Signal. Two of these directors make feasibility report in which they say that buying up the rest of UOP shares for $24 would be a fair deal. Signal eventually offers to buy UOP for $21 per share, and the majority agrees Everything is done hurriedly in a rushed manner P, a shareholder of UOP, claimed that the transaction was not fair Holding: the transaction did not meet requirement of entire fairness 1. Not procedurally fair Signal never really negotiated a fair price 2. Never showed UOP shareholders the feasibility report Fair Price was not satisfied: we know that 21 was not fair b/c Signal would have bought for 24 Fair Disclosure not satisfied: UOP majority did not tell minority that merger was drafted in such a rushed manner without knowledge of the feasibility report 31

Solution: the transaction might have been fair if an independent special committee had been appointed to negotiate with Signal at arms length. It might have been fair if UOP had real bargaining power

LEGAL TEST: 1. Minority shareholder sues; comes forward with facts to raise issue of fairness He says there were common directors involved in this approval process, which raises a question of fairness 2. Conflict of interest: shifts burden of directors to show that this is fair (like Wheelabrator) One way to sanitize this have a majority of shareholders approve it after full disclosure But it did not occur after full disclosure This renders the approval irrelevant in terms of sanitization Burden is still on directors to show that this is fair 3. If directors had been able to prove disclosure and sanitization, Ps have burden to prove unfairness not use business judgment rule Same issue in Wheelabrator: when you have a transaction by controlling shareholder, then shareholders can disclose and sanitize, but burden shifts on P to prove entire fairness (not BJR) (MA) Coggins v New England Patriots: a freeze out transaction is not fair if its sole purpose is to eliminate the minority public stockholders Sullivan is getting loans from bank but he needs to assure bank that all income from company will go towards paying off debt He does this by saying I already own 100% of Patriots Football Club so I need to get rid of non-voting shareholders So he has Old Patriots and forms new company New Patriots OP mergers with NP As consideration for merger, these minority shareholders get cashed out (freeze out merger) They sue Legitimate Business Purpose Test (like Wilkes) (MA court) 1. Controlling shareholder wants to merge subsidiary must show legitimate business purpose 2. Sullivan not able to prove legitimate purpose; if he had been able to prove it, then court would weigh his side versus the minority shareholders side Could also sue Sullivan under dominant shareholder theory (Sinclair) in Sinclair, dominant shareholder has to prove legitimate business purpose by showing that dominant shareholder does not benefit to exclusion of the minority